An Administrative Law Judge (“ALJ”) at the State Division of Tax Appeals sustained two deficiency notices assessing over $15 million in tax against Cushlin Limited (“Cushlin”), a business that acquires and refurbishes hotels. The ALJ determined that the Division of Taxation (“Division”) had a rational basis for assessing the tax and that Cushlin failed to substantiate its claimed losses and deducted expenses. Matter of the Petition of Cushlin Limited, DTA NO. 829939 (State of NY Division of Tax Appeals, July 13, 2023).

The Facts: Cushlin was a corporation formed under the laws of the Isle of Man, and its business model was to acquire and refurbish three- and four-star hotels in New York. Cushlin failed to file tax returns for tax years 2002 to 2008 and was audited by the Division. When Cushlin did file its tax returns, seven years after the audit began, it claimed losses and expense deductions for each year. The Division determined that Cushlin failed to substantiate its claimed losses and deductions and issued two deficiency notices assessing Cushlin over $15 million in tax. Cushlin challenged the assessments arguing that they lacked a rational basis because the Division did not explain the audit adjustments and failed to utilize information contained in Cushlin’s late-filed returns.

The Decision: The ALJ began by stating that the deficiency notices were presumptively correct and that Cushlin bore the burden of proving by clear and convincing evidence that the assessments were erroneous. The ALJ found that because the Division utilized figures provided by Cushlin in calculating the amounts owed, there was a rational basis for the assessments: “Where the division utilized the numbers provided by petitioner that were verified on its real estate transaction database, the division established a rational basis for the tax due in the notices of deficiency.”

The ALJ further found that Cushlin failed to meet its burden of establishing entitlement to claimed deductible expenses and losses. The ALJ found that Cushlin did not provide sufficient documentation to substantiate its claimed deductions and losses, among other reasons, because it did not provide any third-party verifiable documentation or proof of payment for any of the invoices submitted. “Schedules without any source documents verifying the payment are not enough.” Indeed, Cushlin’s witness at hearing, an accountant from the United Kingdom, could not testify that the claimed expenses were actually paid.

The Takeaway: A taxpayer bears the burden to establish claimed expenses and deductions. Conclusory documentation, without supporting source material, will be insufficient to overcome the presumption of correctness that attaches to a notice of deficiency.